“Chapter 2: In Which the Traders Crucible slays the Intertemporal Government Budget Constraint, and Mr. Rowe demonstrates his Worth
There has been lots of confusion lately over at Brad Delong’s place by the usually unconfused Brad. Nick Rowe of the incorrectly named Worthwhile Canadian Initiative jumped in. (why incorrectly named? Should be named “Essential Canadian Initiative” – the dude is freakin’ smmmmaaaarrt, and you’ll see why later.).
But this is about the budget constraint. The Intertemporal Government Budget Constraint has a single, seemingly innocuous assumption of no Ponzi for government spending. The no Ponzi assumption is that the net present value of our spending/debt must equal the net present value of future taxation. The books must balance across generations. If this doesn’t hold, the currency must go to zero. Sounds prudent right?
There is only one problem with this assumption. We cannot know if it is being violated or not with much certainty at all. We cannot see the future. We do not know with perfect knowledge if this constraint holds. We cannot know if the no Ponzi criteria is being held with certainty, because we cannot see the future.
And it gets worse, much worse. We cannot tell if the no Ponzi criteria is being violated within a rather large band of certainty. In fact, anyone who says we conform to the no Ponzi criteria must be lying, given the history of governments. But then, anyone who says we are not conforming to the no Ponzi assumption is lying too. They ignore hard empirical data from today, right now, given todays data, and given history of the United States. So far, the U.S. has held to the no Ponzi quite well.
All the data points to that the U.S. holds to the no Ponzi over time. And yet we are foolish to assume we can hold to it
This to me sounds like a paradox. There is no reasonably certain correct answer.
Is Observation the Key?
Still, We can only know what we observe today.
All we can know today is what people think about the value of their money. If the no Ponzi assumption holds or does not hold, we have to look to current inflation rates to tell us the opinion of what people think is the ultimately unknowable answer. There is no other way to tell other than inflation rates today, because the future is obscured to our observation.
It turns out the assumption is irrelevant for this reason.
The no Ponzi assumption is irrelevant
The no Ponzi assumption kinda sorta ignores the fact that any violation of the assumption has to be observable today.
We know this because the conclusion of the no Ponzi assumption says words like “We would see rates of inflation increase to levels that make g < r if people think the no Ponzi assumption is being violated.” But then people forget we cannot know the future with much certainty, so there is this eternal hand wringing over current inflation rates.
These people cannot know if there is a Ponzi violation. It’s a guess, at best. It’s mad-cap speculation at worst. How can we ever really tell?
Future Ponzi violations or no violations are impossible to know information. They are not falsifiable for any current levels of real growth or real interest rates. Nobody knows, or can know, what the future levels of primary deficits will be 20 or 100 years or 1000 years from today. Anyone can always say “Well, future levels of spending might be too high and spur hyperinflation,” and there nothing anyone could ever say that will prove that statement false. Those levels of future spending might turn hyperinflationary or not, and we cannot know.
Of course they could also say “We are going to be so rich in the future when we energy that costs 5% of current costs that these current deficits are trivial”. How can you tell?
Todays evidence shows we are within the bounds of any reasonable no Ponzi assumption given by Scott Fullwiler. But who in the hell knows? We cannot know the future.
So how does can the no Ponzi assumption help us manage policy real world policy in any practical way? It doesn’t. It’s a myth, a spook story economists tell their kids at night. “Spend too much, and the Intertemporal Government Budget Constraint will get you.”
The only way we can possibly guess if this assumption is being violated is through current inflation rates, real interest rates, and rates of real growth. Even then, these observable rates change all the time. Over the course of decades, these observable rates are all over the place.
Still we have some guidance here with observable market prices of things. All violations of the no Ponzi assumption must be observable. If we don’t have significant inflation, the no Ponzi cannot be being violated as far as we could ever know.
Inflation is the observable change in the price of money in real world goods, services, and transactions, including all financial assets. In other words, the overall market for money will show us the violations of the no Ponzi assumption.
Violations of the no Ponzi assumption must be observable otherwise the EMH is false for the largest, most transparent, most liquid market possible
If the violations of the no Ponzi criteria are not observable for the most liquid and transparent possible market in any economy, then the EMH must be wrong. No EMH in the market for money has devastating consequences.
It’s at this point where I raise the head of the IGBC and proclaim the dragon slain. Either you believe the inflation rate as the only way to tell if people believe the IGBC is holding, or go back to believing in crystal balls telling the future. If you insist on a strong belief in magic, then I hand over the head of the EMH.
As an aside, even if the violations are not observable, it would be foolish to act in any way but to accept the EMH as true in the market for money – which as far as i can tell, is the largest, most transparent, most liquid market possible within current human experience.
This might sound astonishing, but I am not over yet. Living in a no Ponzi world has incredible consequences. Nick Rowe knows exactly what I am talking about. We are living in a world where g is greater than r, nearly all the time, except when some normal business cycle pushes g below r.
Next up, “Chapter 3, in which Mr. Rowe proves his worth.”